As I’ve mentioned before, collaborating with some colleagues overseas I’ve been doing some work on the various models used to deliver property management (as opposed to asset management) by real estate investors. We’re trying to write up the results now. In the UK, the existence of large scale third party suppliers of property management services means that pretty much all real estate investors have the opportunity to outsource this function.
Despite the fact that real estate investment portfolios worth trillions of any major currency need to be managed, the extent to which it is optimal for a real estate investment organisation to outsource property management has been largely neglected. There was a good (US REIT focussed) analysis of the issue by David Fick of John Hopkins University last year – albeit it was sponsored by CBRE (a major provider of third party property management services). Unfortunately from our perspective, it pre-empts many of our findings. Anyway, we’ll get over it.
There’s lots of arguments both ways. The main claimed benefits of internal property management tend to be about brand building, enhanced control, staff cohesion and co-ordination, ability to be entrepreneurial, scale economies and ability to generate profits from property management charges. It’s expected that in the end this model produces to happier tenants, less voids, more added value and better risk-adjusted returns.
Alternatively a number of benefits of external property management can be proposed such as economies of scale in purchasing, contracting and human resource efficiencies that large scale external managers such as CBRE and JLL can generate (obviously the argument can be used by both sides). In addition, it is argued that quality assurance tends to be more rigorous in outsourced models that tend to have more standardised systems and metrics. Finally, there is the ability to shift the costs of adjusting the composition of the real estate portfolio in response to strategic and tactical allocation decisions.
In terms of optimality, we can look at what different types of real estate investors actually do. It seems clear that some real estate investors regard property management as a core competency, whilst others don’t.
In the UK, real estate investors that concentrate on specific locations (Grosvenor, Shaftesbury) or specific sectors (Intu) tend to deliver property management internally. Possibly as a result of specialist focus, this type of real estate investor will be more likely to (or be able to claim to) have deep domain expertise in a specific location or sector. Such specialist locational or sectoral knowledge may be difficult to obtain from third party suppliers.
Organisations that specialise in real estate investment (but not in specific sectors or locations) such as Land Securities and Intu also tend to manage properties in-house. In the US, most major REITs manage their properties in-house. Again their specialist focus on the real estate sector provides an opportunity to create deep domain expertise in operational real estate management. However, there are exceptions to this pattern. For instance, major real estate-focussed investment management organisations such as Lasalle Investment Management and CBRE Global Investors with a large number of mandates and assets across a range of international markets tend to use third party providers for property management.
Finally, there are a broad range of investment organisations that invest across multiple asset classes and/or have multiple business streams for whom real estate investment is a relatively small proportion of their total assets/business. In reality the composition of their real estate portfolios may be similar to REITS – albeit their holding periods and liquidity preferences may be different. In the UK , for such investment organisations, property management tends to be regarded as a non-core competency and is outsourced to third party providers. Such organisations are diverse in terms of scale and scope and include investment banks, fund houses, life assurance companies, pension funds, sovereign wealth and endowment funds etc. I can’t think of a single one in the UK that does property management internally. Indeed, this type of investment organisation can even claim its core competency is managing supply chains of third party service providers or outsourcing!
Clearly, the different approaches may be more or less suitable for some real estate investors compared to others. It’s unlikely that a global real estate investor who regularly re-structures their portfolios would find it optimal to create an operational property management platform in every market where they had assets. In contrast, investors in specialist real estate assets such as certain types of leisure property would find it difficult to find third party suppliers.
However, for similar portfolios of assets, which model performs best? We don’t know. We’d really need to try to assess whether, all else equal, externally managed property assets perform better or worse than internally managed property assets. It could be done. With appropriate controls for differences in other variables (location, WAULTs, building age and quality, tenant quality etc.), it should be possible to identify whether the management approach makes any difference to performance. Over to MSCI/IPD?